Managing Geopolitics......Learnings from Europe
For years whilst training and sharing insights with business executives on managing global risks, I would observe how little geopolitics is considered when developing corporate strategy. It is the intersection of politics, geography, and sovereign ambition, influencing everything from travel to food security yet still relegated to casual social conversations. That is changing by force. Businesses and governments are now being challenged to move beyond the headlines and carefully dissect whether the headlines can threaten economic health or propel it. Greater global interconnectivity makes our neighbors risk ours and therefore the volatility that follows is creating a greater sense of vulnerability. A crisis in one country spreads like wildfire to others spiking inflation levels and depriving other territories of needed resources. We must therefore appreciate that when geopolitical forces shift, so too must the assumptions we use for our corporate strategy and risk management practices.
In 2021, EY-Parthenon conducted a survey where 90% of executives indicated they were impacted by geopolitical risk during that year. 33% of those leaders were surprised by the emerging political risks 50% of the time with no clear path to managing them. Other global consultancies have conducted similar studies highlighting a gap in managing geopolitical risk. Leaders must therefore develop a strategy that incorporates political risk management with a solid governance framework to support it.
Geopolitical Forces have been sparking global trends. There is supply chain diversification with nearshoring being an example of de-risking critical segments of your supply chain vulnerable to distance. Protectionism of strategic assets is replacing free trade and regionalism is being fostered to replace volatile foreign alliances. These are illustrative of steps taken by countries or companies to survive in an unpredictable world. An interesting case study on responding to geopolitical risk is Europe’s response to the Ukraine-Russia war. The overarching themes are that of independence and energy security however it provides a framework and insight into the breadth of thinking that should go into responding to geopolitical risk and uncovers the different barriers of protection that are often needed to ensure that resilience is embedded into national and corporate structures.
Understand your Objectives
When Russia declared war on Ukraine, Europe responded based on its values and principles. They believed in sovereignty and territorial independence so they placed economic sanctions on Russia which ran afoul of those values. The aim of the economic sanctions was to impose severe consequences on Russia for its actions and to reduce the Russian ability to continue the aggression. EU’s action was intended to protect economic interests, thwart further onslaught, preserve their reputation/ political brand, and demonstrate regional clout.
When faced with emerging risks or actions that are likely to introduce uncertainty, one should step back and determine whether there are any past experiences that one can rely on or patterns that one may have observed in the environment to inform decisions. Each decision taken must be in the context of not only your objectives but must be framed taking into consideration your internal and external context. The EU had heavy dependency issues on Russia and the latter had a history of reducing supplies as a means of exerting dominance in the region.
Cyberattacks on critical energy infrastructure were a norm. The EU had to acknowledge that it relied on natural gas for 25%-50% of its electricity and 80% of this was imported from a small group of suppliers reducing its choices. Europe was connected infrastructurally via pipeline to Russia and there were limitations with its LNG import terminals. This included bottlenecks in transmission capacity and location disadvantages limiting access by other European countries. The concentration of assets in the Iberian Peninsula meant that the construction of new terminals needed to be planned in other locations to ease access and distribution. The latter was also not a short-term fix.
Identify Your Risk Exposure
Every action has a reaction and every geopolitical event can either threaten, stabilizes, or enhance your ability to achieve your objectives. The EU understood its vulnerability in that its domestic natural gas production was declining for years and therefore it was heavily reliant on a fickle and antagonistic supplier for a key resource. It also had to acknowledge that Russia’s actions were a destabilizing force that could threaten regional peace. They also understood that taking a stand would threaten their economic interests. It would threaten their economic security as Russia would likely retaliate and weaponize gas flows. Russia was the EU’s key supplier of fossil fuels needed for heating, industrial processes, and power. They supplied 40% of the EU’s natural gas and 30% of its crude oil (Eurostat, 2021). Through a combination of deliberate reduction of imports and Russia’s deliberate attempt to choke pipeline access to their gas, supplies of Russian natural gas were curtailed by 80%. Though the EU had storage to protect against sudden disruptions (1147 terawatt hours across member states), the storage could only cover 25% of annual demand and was unevenly distributed throughout the Union, and was only meant to protect against seasonal weather shifts, not sustained supply curtailment.
Identify areas of Focus, consider your options, and determine the cost-benefit trade-offs
It became clear to the EU that they had to rethink their energy supply and wean off Russian fuel. It had to pursue diversification but this would not be without risk. Global gas production comes from a few countries that were blessed with natural resources. Though it may be diversifying from Russia, it would be creating new dependencies with other countries that may lack stable political regimes. Some of the actions that they would take could also inconvenience consumers with exorbitantly high energy prices. Environmental consequences had to be considered. The EU inevitably had to increase their consumption of coal as a means of remaining energy secure. Choices made could hamper Paris Agreement commitments and slow the path to net zero.
Set Clear Expectations, Establish Buyin and Determine Your Action Plan
Diversification was a priority. The EU increased flows via pipeline from Norway, Algeria, and Azerbaijan. They also increased LNG imports from the US. The latter supplied 42% of its LNG supply in 2021. The EU established buy-in within its bloc and between its economic partners. All parties were aligned on geopolitical interests and why certain mitigations had to be implemented quickly. It also reduced its demand for fossil fuel energy by 20% pursuing energy efficiency initiatives, increasing renewable energy production, and encouraging behavioral change in the public’s energy consumption habits. It addressed the high energy prices by instituting price caps and establishing new regulatory rules for its energy markets.
Understand Implications and Develop Scenarios
The EU understood that it had to look at the entire picture and build layers of protection to become future-proof. Yes, its energy infrastructure was identified as the most vulnerable but they used that as a lesson learned for how it should treat with other vulnerable sectors. Conversations were therefore not only about Russia and accelerating the energy transition but on weaning itself off other partners like China which it depended on for key technological resources. EU in parallel instituted a European Critical Raw Materials Act to support its ambition to become more self-reliant in microchips and batteries.
Monitor New signals and Continuously Improve
The EU’s response was reactionary. Some may say that they failed to heed geopolitical signals and squandered the years available to reduce their energy dependency on Russia. The bloc however was able to quickly coordinate a response that increased investments in clean energy and refined its energy security efforts. It improved its legislation and introduced new mandates for winter storage whilst continuing to focus on coordination and solidarity with its economic partners.
The case study presented should prompt some introspection. We must judge whether our region, country, or companies would have a coordinated approach if faced with a geopolitical crisis. If not satisfied, let us rethink how we conduct geopolitical risk oversight and demonstrate risk leadership. The competition for global dominance will restrict access to resources, forge new industries, and alliances and globalization will continue to take a new form. Our decision to act must therefore be influenced by our objectives taking into consideration the interconnectivity of our value chains and levels of vulnerability. We must probe whether our systems are risk intelligent allowing us to quickly detect risk, rehearse scenarios and launch a response. Geopolitics will continue creating political, economic, and societal havoc with systemic effects. We must therefore be proactive in fostering relationships to collaborate on mitigations.
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